Category: Strategy

Tech startups are a strange thing when it comes to valuations in the early days. When you’re just starting out, have great social proof, but no revenue, there’s a real chance that the valuation is higher than when you’ve started to monetize things and have some revenue. Investors and potential acquirers see the startup and make educated guesses as to how fast the business will scale, potential gross margins, and monetization opportunities. Since these are educated guesses, there’s a good chance they won’t pan out as predicted, but no one knows.

So, if an investor or potential acquirer comes along and offers a high price based on hype, social proof, herd mentality, or whatever, there’s a chance the entrepreneur will be staring at the deal and thinking that the startup is being valued at such a high price, it’ll take a couple years to get back to that value, and possibly many years (e.g. Instagram). For startups in hot areas or great timing, there’s a startup valuation anomaly phase.

What else? What are your thoughts on some startups having a valuation anomaly phase?

In Great by Choice, the most recent book by famed author Jim Collins, he talks about 10x companies (companies that outperform the market by 10x) and how they do a better job shooting bullets, as opposed to cannonballs, for new opportunities. Think about the cost of bullets and guns vs the cost of cannonballs and cannons — bullets are significantly cheaper than cannonballs.

Most startups come up with a new product idea and fire a giant cannonball at it without knowing if they are pointing in the right direction and actually have a target. Instead, they should use bullets and iterate quickly to try and find the target. Once the target has been squarely hit by the bullet, doubling down and loading the resources to fire the cannonball at the same target becomes a much more effective strategy.

Startups should shoot bullets to find a cannonball opportunity. This is another way of saying start with a minimum viable product and iterate quickly via customer driven development — a core part of the lean startup movement. The next time a startup builds a full product and launches it with significant resources, and it doesn’t work out, think to yourself that they should have fired bullets until they hit the target, instead of lobbing a cannonball out there right off the bat.

What else? What do you think about startups shooting bullets to find a cannonball opportunity?

With the growth of the sharing economy, and services like Zipcar and Portico Club, people are growing more accustomed to paying a membership fee for access to a service where you then pay a per usage fee, and save money overall compared to buying the item outright. Well, there’s a startup opportunity in the same manner to serve the supercar/exotic car market.

High end sportscars are a niche, but healthy market. These supercars and grand tourers are different from the normal car approach in two key ways: they aren’t usually the daily driver for the owner and the owner isn’t looking to have the same car for many years. Like taking a vacation and enjoying the experience of something new, the same can be said of supercars but the current economics don’t make sense. If you want to experience a car you can try to test drive one, which is a short experience and potentially not possible depending on your circumstances, or you can rent one for $500/day, which again is short and highly restrictive.

Owning a super car is very expensive and out of reach for most people. Here’s a simple break down of costs for an example $150,000 supercar:

• $3,000/year in lost investment income (assuming 2% return on investment, and the money spent on the car is fairly illiquid at that point) or $6,000/year in interest if the car is financed
• $3,000/year for car insurance
• $10,000 for sales tax, spread out over two years (assumed length of ownership), for an average of $5,000/year
• $3,000/year for service, repairs, and tires (crazy expensive!)
• $18,000/year for depreciation (new Porsches and Ferraris hold their value much better than Aston Martins and Mercedes, as an example)
• Total: $27,000/year if bought outright or $30,000/year if financed

For simple math, assume most $150,000 supercars are financed, resulting a fully loaded $2,500 monthly cost to the buyer to own and operate the vehicle. Assume the car is driven 3,000 miles per year, resulting in a cost of $10/mile, not counting gas. Surely, there’s a better way.

Imagine a Zipcar-style service where you pay an annual membership fee and then have a variety of supercars to choose from, each assigned a point value based on their current market value, and then for a per day/week/month cost, you can take the car as long as you want. The cost to have it will be less than the fully loaded cost of ownership, capital won’t be tied up in the vehicle, and you can swap it out when you’re ready to try the next one. Even if the price of the service was similar to the cost to buy (e.g. $2,500/month) it is still much better to do the service since there’s transaction costs (like shipping, finding the right car, worrying about its quality, dealer markup, etc) and peace of mind that you can enjoy it and move on.

Plus, when you buy a supercar, as opposed to leasing one, there’s the risk that you get in an accident, and even though insurance covers the repairs, the resale value of the vehicle drops by 10%-20% since it now has a blemished Carfax and there’s uncertainty as to the quality of repair, extensiveness of damage, etc. With a Zipcar-style service, that risk goes away.

There are a number of different ideas to go along with this potential startup:

• Example cost might be $5,000 to join, and then a monthly fee depending on the type of car you want (e.g. $1,500/month for a 2008 Audi R8, $2,000/month for a 2011 Porsche 911 Turbo S, and $4,000/month for a 2010 Ferrari 458 Italia, all paid on a credit card)
• Opportunity to make a membership and certain number of points as a corporate benefit (e.g. the top sales person for the quarter gets a super car for the next quarter)
• Optional: members could take a supercar that they own and let other members use it to accumulate points that they can use to rent other supercars (in general the cars would be owned by the company and not by individuals, so as to be more exclusive and not have the fate of services like HiGear, plus the $5,000 membership fee and background checks would reduce the people who joined)
• Supercars could be very loosely defined as cars with a manufacturer’s suggested retail price of at least $100,000 USD
• Certain cars could be designated track cars whereby you’d be allowed to take them to a track (like the new Atlanta Motorsports Park)
• Advertising would done through local enthusiast groups like Caffeine & Octane, Google AdWords, etc
• Free pickup and delivery of the cars to members within a 30 mile radius and service to ones further out than that at a rate of $1/mile (e.g. you live 100 miles from the local location and for an extra $100/car you can have it delivered to you and $100 to have it picked up whenever you are done)
• High end vehicles like the Ranger Rover Signature Edition could be made available (e.g. to take to the mountains for a weekend)

A Zipcar-style model for supercars holds tremendous promise, especially through franchising or multi-city expansion. The sharing economy continues to grow and shows no signs of slowing down.

What else? What are your thoughts on the startup idea for a Zipcar-style business for supercars?

In the first issue of Build, from the team at Inc. magazine, there’s an article with the headline: One way to evaluate the strength of your business model is to assess how difficult it is for your customers to leave you. The work comes from Rita Gunther McGrath, a professor at Columbia Business School.

The idea is to rate the business model’s attractiveness based on 10 questions with a scale of one to seven for each, with a score of one being fully aligned with the first statement and a score of seven being fully aligned with the second statement. Once each question is scored, add up your total score, and if it’s 40 or higher you’re in the preferred zone. Here are the 10 questions to assess a business model’s attractiveness:

1. The cost to a customer of switching to another provider is relatively low
   1 – 7
   The cost to a customer of switching to another provider is relatively high
2. The model is based on individual transactions that must be repurchased each time
   1 – 7
   The model is based on a series of transactions (such as subscriptions) subject to renewal
3. The user interface for the model is nearly the same for all providers (for instance, an ATM)
   1 – 7
   The use interface differs among providers (it’s easier for users to stick with one system)
4. The benefits provided by the model are optional or discretionary
   1 – 7
   The benefits provided by the model are mandatory
5. There are few network effects in this business, we are a late mover
   1 – 7
   We have the potential to create positive network externalities in this model
6. This model solves the customer’s problem once and for all
   1 – 7
   The customer’s problem is ongoing
7. The model is arm’s length or transactional
   1 – 7
   The model establishes some kind of relationship
8. The model has little impact on the customer’s experience, or the impact is negative
   1 – 7
   The model changes the customer experience significantly, and the impact is positive
9. The model operates on a stand-alone basis
   1 – 7
   The model creates a platform others can use to accomplish their goals
10. We create the offer
    1 – 7
    The offer is to some extent cocreated

This is a great methodology for quickly assessing a business model’s attractiveness. As you can see, Software-as-a-Service with strong customer service and high renewal rates score very high in this model.

What else? What are your thoughts on this methodology of assessing a business model’s attractiveness?

Most entrepreneurs looking to start a new business have a limited number of startup ideas and eventually pick one from a small list. Some entrepreneurs on the other hand have a gift for coming up with startup ideas, but then like having too many choices of cereal at the grocery store, run into analysis paralysis and get bogged down making a decision. Of course, picking a startup idea is a huge decision, so it shouldn’t be taken lightly.

Here are a few things to consider when picking a startup idea:

• Market Timing – Is this an idea that’s going to be successful some day but timing the market will be critical to success or is clear that the opportunity is in the short run (e.g. next 1-2 years)?
• Domain Expertise – How much experience do you need to be productive for this startup? Does not having experience help so that you have a fresh perspective?
• Capital – How capital-light or capital-intensive is the startup idea and what are you comfortable with?
• Passion – How passionate and committed are you to the industry and opportunity vs something that you think will be successful but aren’t that interested in?

Picking a startup idea is a big decision but picking a market to be in is a monumental decision. I’ve never met an entrepreneur that was successful with their original idea — the idea always changed but their market rarely did.

What else? What are some other things to consider when picking a startup idea?

Today I had the opportunity to hear Jim Collins at a workshop in Atlanta courtesy of EO Atlanta. Jim was amazing, truly amazing — so much energy, passion, and enthusiasm. At the very end he gave a list of 10 things leaders should add to their to do list.

Here are the 10 to do items courtesy of Jim Collins:

1. Change your next big ‘what’ question into a ‘who’ question
2. Double your questions to statements ratio
3. Try to embrace the Stockdale Paradox – going along in life and get knocked down, and it happens over and over again
4. Discover your personal hedge hog and focus on it
5. Set your vision on three components: 100 year core values, purpose that answers question who would miss you if you disappeared, 25 year BHAG
6. Set your 20-mile march
7. Start a stop doing list (and have no more than 3 priorities)
8. Turn off electronic gadgets and create pockets of quietude for one day every two weeks
9. Get a huge return on next luck event
10. Change from striving to be successful to being useful

I’d recommend reading his books as well as attending his events.

What else? What are your thoughts on the 10 to do items from Jim Collins?

Most startups should not raise money. Some exceptions include when it’s a winner take all market (like eBay), winner take most with a huge valuation boost (like Salesforce.com), or very capital intensive (like a hardware business). In this context “raise money” means the traditional large sums of money over multiple rounds approach. There’s another  approach that isn’t talked about as frequently: raising limited money to get key people formally involved.

By raising limited money you might sell 2 – 10% of the business to get key people participating instead of the traditional 20 – 40% (usually 30%) per round, not because you need the money but because you want them formally involved. You might say you could do that through board seats or advisors — you could, but it’s better if they have some skin in the game through a formal investment as well as the board/advisor participation.

The next time you want to get a person involved in the business for a long time, and you’re not raising money, consider raising money from them as a way to align interests and formalize the relationship.

What else? What are your thoughts on raising limited money to get key people formally involved?

After the post last week outlining an example value multiplier of 5 to raise VC money, an entrepreneur pointed out to me that some startups choose a middle ground between bootstrapping and raising institutional money: exclusively raising angel money. Comparing angel investors to VCs is relatively straightforward but there isn’t much talk about startups that only raise money from angels.

Only raising money from angels would be considered for a more capital-light business with the idea that there might be three rounds over five years raising amounts more modest than from VCs (e.g. $500k, $750k, and then $1 million for a total of $2.25 million). By raising money from angels it’s likely that there wouldn’t be the typical 1x participating preferred liquidity preference and that the angels wouldn’t require selling roughly 1/3rd of the company for each round (the 10-20% range would be more likely).

Let’s look at the math from purely a co-founder’s financial return for only raising angel money vs bootstrapping:

• As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
• At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
• As a co-founder that owns 40% of the business, assume you raise three rounds of angel financing (roughly one every 18 months). Assume angels buy approximately 15% of the business with each round of financing and assume the option pool grows by 5% (less hiring with less money), so multiply the ownership stake by .8 (representing the amount sold to the angels and the amount for the new option pool). Here’s the math: .4*.8*.8*.8 which equals 20.5%.
• Assume everything else is equal, which it isn’t, the value multiplier to raise angel money is 2. That is, it makes financial sense to raise angel money if the business will be significantly greater than 2 times more valuable in five years.
• A quick example: if you can build a company worth $10 million with no angels, the same company would have to be worth $20 million for the personal gain to be financially equivalent.

Raising angel money, depending on the terms, is likely to be slightly more entrepreneur-friendly than institutional money, but still requires the full commitment of a board and other fiduciary responsibilities.

What else? What are your thoughts on the value multiplier to only raise angel money?